The Superannuation Industry Supervision (SIS) legislation provides for the offering of investment choice to members. Investment choice allows a beneficiary to direct a trustee in the allocation of the beneficiary’s interest in the fund.
In October 2002, the Government accepted a recommendation that the Australian Prudential Regulation Authority (APRA) update its guidance on managing investment choice to more clearly enunciate the rules governing diversification and liquidity of investments. The new licensing framework and risk management plan requirements also cover these issues.
Under SIS, a trustee is required to formulate an investment strategy that covers all of the circumstances of the fund including, but not limited to, risk and return, diversification, liquidity and the ability to discharge existing and prospective liabilities.
A strategy must be in accordance with these requirements even if it provides for a specified beneficiary to give directions to the trustee where the directions:
n relate to the strategy of the investment or assets of the fund, and;
n are given in circumstances covered by regulations.
APRA accepts that, provided a trustee has properly developed each strategy offered and has disclosed the necessary information, a beneficiary may then direct the trustee as to the investment of his or her interest in the fund.
Since the implementation of the SIS legislation over 12 years ago, trends in the offering of investment strategies to beneficiaries have developed from a limited range of generic strategies to the wide variety of asset strategies on offer today.
At the extreme, APRA has observed some funds offering a wide range of strategies, including single asset strategies, with the trustee permitting a planner to set the fund’s strategies, relying on the planner’s sign-off for the allocation of a member’s interest in the fund. Where single or highly concentrated asset choices are offered, there has been insufficient trustee imposed requirements for even minimal diversification of a member’s investment in the fund. Although the legislation permits beneficiary investment choice, a solely member-directed investment is not in accordance with the SIS legislation. This is to ensure that diversification principles still apply to ensure that members are not exposed to inadequate diversification.
APRA’s view of the trustee’s responsibility for formulating and implementing investment strategies is set out in Circular II.D.1 and has not changed. Accordingly, while planners may recommend a particular investment choice be added by the trustee, the trustee must make the relevant decision in the context of the fund as a whole.
The inference APRA draws from the practice of trustee reliance on financial adviser sign-off is that securing a sign-off is considered to relieve the trustee of the duty of the extent to which the fund’s investments as a whole are diversified.
There is also the inference that the planner is helping the member make allocations that are optimised across the member’s entire financial position, not just within the super fund. APRA cannot accept that decisions relating to super assets can be adjusted in the light of the client’s non-superannuation position. Trustees can, in practice, only consider the position of the member within the fund on a stand-alone basis.
The view that otherwise imprudent super fund investments could somehow be balanced by other non-superannuation investments of the member seems to APRA to be questionable in a legislative and policy sense. The preservation requirements that apply to superannuation are designed to achieve long-term social security outcomes, while non-super investments available to be cashed at will cannot be aligned with that objective.
By failing to prescribe a reasonable spread of investments at the member level, trustees abrogate responsibility for prudent management of a member’s interest in the fund, and lose control of the extent to which fund assets as a whole are diversified. They may also arguably lose the protection afforded by SIS in respect of a properly formulated investment strategy.
APRA is concerned that its views on trustee obligations have been misinterpreted. The fact that a trustee is not responsible for the choices an individual makes does not mean that members can direct the trustee to make any investment from the available strategies without regard to diversification.
Investment choice cannot abrogate trustee obligations. They still have responsibilities to ensure that protections provided by diversification are not eroded. This means offering choice within a set of rules that take into account all of the factors in APRA regulations. In particular, trustees should impose constraints to ensure a sensible diversification across asset classes.
Trustees that apply for an registrable superannuation entities (RSE) licence must develop a risk management plan for each fund for which they are trustee. A risk management plan that meets the requirements of section 29P of the SIS Act is a pre-requisite to the registration of the fund with APRA following the granting of an RSE.
As a general rule, allowing members unrestricted choice of equities or other securities is an approach that opens up the risk of asset concentration. Trustees should establish a framework of permissible directions that may be given by members in relation to choice of investment options. The framework should enable trustees to balance the individual member’s desire for growth with the need for security of benefits.
APRA sees no prudential merit in permitting a member to invest more than 5 per cent of their interest in the fund in a single asset, with perhaps the exception of holding of a member’s interest in cash pending imminent cashing of benefits.
— Ross Jones is the APRA deputy chairman
